Tensions in Cyprus over bailout underscore pitfalls ahead

The ink is barely dry on a deal struck in Brussels to save Cyprus from bankruptcy, but rising tension between the island's conservative president and the Communist-appointed governor of the central bank foreshadow difficulties ahead.

Thinly veiled disdain for governor Panicos Demetriades expressed by officials close to President Nicos Anastasiades has reinforced the perception of a Cypriot leadership reeling under the backlash against an unpopular, last-minute accord hammered out in fraught negotiations in Brussels.

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Small and so-far peaceful street protests appear to be gaining momentum, and the opposition - denied the right to challenge the deal in parliament - is calling for a referendum.

With banks closed for 10 days and capital controls being readied for when they reopen on Thursday, analysts say Cyprus's economic contraction is likely to accelerate, potentially undermining the forecasts that underpin the 10 billion euro ($13 billion) EU/IMF lifeline.

As the experience of Greece has shown, the pitfalls are legion.

Appointed in May by Anastasiades' Communist predecessor, Demetriades' role is crucial, with the central bank overseeing the restructuring of the island's largest bank, winding down its No. 2 lender and handling banking restrictions to avert a flight of capital when lenders reopen on Thursday.

But officials say the relationship is fraught with difficulties.

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"There is a complete lack of communication between the central bank and the president's advisers," said an expert involved in talks to resolve the island's banking crisis.

"The central bank has lost the respect of the president and the banking sector," he said, speaking on condition of anonymity.

A spokeswoman for the central bank did not respond to phone calls from Reuters for comment.

"FURIOUS"

The two sides have clashed over the timing of highly sensitive announcements regarding the resolution of Cyprus Popular Bank, also known as Laiki, and the reopening of banks that have been closed for 10 days to avert a run on deposits.

Both measures have infuriated ordinary Cypriots, piling pressure on Anastasiades' one-month-old government as it wrestles with Cyprus's worst crisis since war in 1974 split the island between the Greek Cypriot south and Turkish Cypriot north.

On Monday, there were clear tensions over when and how to reopen the banks, with the central bank first saying some would open earlier than Thursday, before retracting the statement.

A government official told Reuters that Anastasiades was "furious" at the initial announcement, and pushed back an address to the nation three times as he met with Demetriades, a fierce critic of austerity in his former role as professor of economics at Britain's University of Leicester.

"It will be an absolute disaster, a disaster," a ruling party official said as he paced the lawn at the presidential palace.

Finance Minister Michael Sarris publicly questioned the logic.

"Logical people might disagree, but the governor believed it better, rather than to extend the closure of the banks, to take the risk and open them," he said late on Tuesday. Many in the EU, he said, "thought this would be very dangerous."

The bailout package has put intense pressure on the relationship between the government and the banking sector, crippled by its exposure to Greece, the epicenter of Europe's debt crisis.

BACKSLIDING

The banks face severe contraction and job losses, while Cyprus will almost certainly lose its status as a hub for offshore finance, particularly for wealthy Russians.

Criticism of the deal, which sidestepped parliament and will likely condemn Cyprus to even deeper recession, is widespread.

"An extremist idea has been implemented without the approval of the elected bodies," Pambos Papageorgiou, a lawmaker from the opposition communist AKEL party, told Reuters.

"This demonstrates a huge democratic deficit."

Analysts warn the island risks the kind of backsliding seen in Greece as leaders recoil from politically unpalatable austerity.

Elias Neocleous, a prominent Cypriot lawyer in the coastal town of Limassol whose client portfolio includes Russian billionaire and Bank of Cyprus minority shareholder Dmitry Rybolovlev, compared the bailout deal to an ultimatum - "either you commit suicide or we kill you," he said.

"In the next few weeks we'll see exactly how much damage has been done," Neocleous told Reuters.

"Some of the policy decisions that were taken at the political level might haunt the people who took them."

Adding to the sense of turmoil on Wednesday, Yiannis Kypri, the Chief Executive of Cyprus's largest commercial bank, Bank of Cyprus , said he had been dismissed by the central bank, "upon demands of the troika", a reference to Cyprus's trio of lenders - the EU, European Central Bank and International Monetary Fund.

It follows the appointment of a special administrator to run the bank and the resignation of Chairman Andreas Artemis.

Some bankers have defended Demetriades. He has more than four years left of a five-year post, which is independent of the government, and complex constitutional procedures make his dismissal difficult.

"The central bank governor has done an excellent job so far," said one banker who recently left the board of a major Cypriot bank. "I'm surprised politicians are pointing the finger at him."

Demetriades has said he has no intention of stepping aside in light of the government criticism, saying that he enjoys the trust of the European Central Bank.

Asked on Tuesday about his relationship with the governor, Finance Minister Michael Sarris told state television: "As long as the governor is in that position, it is my duty to work with him."